Your Brokerage Account
Throughout this course, we have learned the basics of investing and how to get a winner portfolio strategy.
Now you are ready to start putting it all into practice, and finding the right broker is the first step to get started.
Before discussing brokerage accounts, we should understand what a broker is:
What are investment brokers?
An investment broker is typically an entity (or an individual) that acts as an intermediary between investors and security exchanges in order to trade some sort of security.
- Securities are financial assets like stocks or bonds.
- Investors are individuals or institutions that are interested in buying or selling (trading) securities.
- Security exchanges are huge market places connected globally where member investors or institutions (brokers) trade securities of companies that are listed in these exchanges. We will discuss this further in future sections.
The broker is the element that links those components together.
As an individual investor, you can’t actually buy or sell assets from a security exchange. Only a licensed professional that is a member of that exchange can do that for you, which is called a broker (stockbroker or brokerage firm). These brokers ensure that the transactions are done following the legal and regulatory procedures that exchanges require. They will execute your asset buying or selling decisions (orders) on your behalf for a fee.
Comparison: when you are at a restaurant and you feel like eating spaghetti, you can’t just go to the kitchen and cook it yourself. What you do is, you order it to the restaurant staff, they make the plate and they deliver it to your table, you enjoy your spaghetti and then pay for the service.
Something similar happens with trading securities through a broker:
- You place an order to trade a certain security (you order spaghetti)
- The broker (restaurant staff):
- receives it (takes order),
- processes it (places your order to the kitchen),
- and executes it on your behalf (cooks your meal)
- You own the securities you wanted (you enjoy the food)
- You pay trading fees (you pay for the service)
A brokerage account
When you are ready to start investing you will have to create a brokerage account with a broker of your choosing, which will provide you with an online platform for you to trade and track your investments.
A brokerage account is essentially a contract between an investor (you) and a brokerage firm where the broker provides a platform for the investor to…
- deposit investment capital (money)
- place the buy and sell orders
- gain ownership of assets (when orders are executed)
- hold and manage the portfolio of assets
- receive income from investing (if entitled to dividends or fixed income) and/or generate capital gains from selling profitable investments
In return for these services, the broker charges some pre-established and agreed upon fees.
Process to find the right broker
Now that we have a killer portfolio strategy, and we know what brokers and brokerage accounts are, we can start discussing the simple process to get started:
Step 1: Figure out what you need
If you have been following this course, you may already know what we mean. Before starting to research on investment or brokers or anything else, you must think about what you want, what’s important for you.
What type of securities do you want to invest in?
If you are starting out, you may want to limit yourself to stocks, mutual funds, and ETFs. More experienced investors can adventure into options, futures, etc.
What is your level of involvement?
Are you an active or a passive investor? Will you be buying and selling assets daily? Do you care for analysis and charting tools? As we have seen, active investors try to time the markets and look for trading opportunities very frequently by analyzing charts and trends so they may want a brokerage account with high-quality analysis tools. And passive investors tend to leave their portfolios alone for long periods and only rebalance them every once in a while.
What are your goals and objectives?
If you are investing for retirement, you may want an IRA account, which offers great tax benefits. But if you are investing for shorter periods or need a certain level of liquidity, those types of brokerage accounts may not work for you.
Step 2: Compare and understand the costs and perks
As we have mentioned, brokerage firms charge some set fees and commissions for offering their services. It is very important to take into account these costs because they tend to add up really quickly and they can affect your portfolio’s return significantly. For instance, if your broker charges you 1.5% of your capital in fees and commissions, and your portfolio earned an 8% last year, you would only get a 6.5% (8% – 1.5%). Over time, this difference is noticeable and it can hurt your real performance.
Let’s look at an example and compare different brokerage accounts by their costs and how they affect your returns:
Imagine you invested $500 a month for 20 years and earned an average 8% annual return. At the end of the 20 years, you would have invested a total of $120,000. Let’s see what that would grow to and how brokerage costs would affect your returns:
The first column in the table shows the cost of trading altogether in a percentage form, the percentage of your total capital that a broker charges you for the services. The second column shows how much you would have earned after 20 years of investing with the parameters we specified above. The third column shows how much the brokerage costs would add up at the different annual cost percentages.
At the end of the 20 years, your investments would have grown to almost $295,000, but your brokerage firm charged you 1.5% in fees every year, so you essentially gave away about $50,000.
Costs are very important when picking the right brokerage firm as you can probably see in the above table. However, there are other factors to consider, which depend on your needs.
There are plenty of big, reliable online commission-free brokers which get the job done fairly well. Also, many brokers offer discounts and incentives if you join them.
For US investors we recommend robinhood.com, which is one of the best and most popular online commission-free brokers in America.
For European investors, we believe that eToro.com is a great commission-free broker that offers many perks and analysis ideas.
In future sections, we will dig into brokerage fees and expenses since it is such an important factor.
Step 3: Compare the services offered
It is not all about costs tho. There are many other factors to consider. Here are some of the things you may want to consider and shop around for when trying to find a good broker:
- Asset classes available: as we mentioned earlier, if you are starting out, you may be ok with investing in ETFs and stocks, but when you gain some experience, you might want to try trading options, shorting stocks, etc. So, make sure your broker offers all those if it’s what you’re looking for.
- Assets available: a big issue we have found with some commission-free brokerage firms is the diversity of assets they offer. It is really annoying when you are researching a strategy, you are all ready and then you find out your broker doesn’t offer the specific asset you need. So, make sure you research their list of available assets beforehand.
- Research: many brokers provide research about assets they offer. It can range from just some basic technical analysis summary to a full asset analysis, forecast, and recommendation. We believe that a lot of the technical analysis they provide can be too short-term and may not be ideal. Also, they normally jack up their costs significantly if they offer good analysis.
- Platform: there are many types of trading software out there, some are really good and some aren’t. You may be interested in having some nice charting options, or some solid comprehensive dashboard. Most brokers offer some sort of free platform testing route. We advise that you try out multiple platforms and see which one you like the most.
- Ease of use: many brokers are too advanced and unnecessarily complicated. You may want to choose a broker whose platform is easy to use and to understand.
- Deposit and withdrawal: depending on your liquidity requirements, you may want to consider the ease of withdrawal of your funds. And if you are planning on adding funds periodically, it is important that your broker allows for an easy (and hopefully free) process. There are brokers that offer automatic deposits or withdrawals, so that can also be a plus for you.
Step 4: Pick a broker
Once you know what you want, you shopped around for prices, and you compared services. You may be ready to make the final decision and choose a broker. However, we recommend to do the following:
- Narrow it down to your top 5 brokers based on the price and services described.
- Try out each one if they provide free trial options or free paper accounts (trading with fake money). Weight the pros and the cons based on your needs, constraints, and objectives.
- Choose the broker that you like the most and that you feel best fits your needs.
Step 5: Follow the account registration process
Once you choose the right broker for you, it’s time to actually register online. They normally guide you through the process step-by-step. They should ask you for some identification information (since this is a legal contract, they have to make sure it is you). They may require an ID or passport, your Social Security Number, your address, some proof of residence, etc.
Also, they will probably ask you about your financial situation: goals, income, net worth, experience, etc.
This process can feel a little invasive and extensive sometimes. But you must remember that you will be entering into a legal contract with the broker and there are many regulations and requirements to fulfill that are established to protect both you and the broker.
Step 6: Apply your portfolio strategy
Alright, if you got to this step, you have done it! You have successfully created a brokerage account and are ready to implement the portfolio strategy you created.
Fund your account
To start applying your strategy, you will have to deposit the amount you planned to invest in the account.
For instance, Jim wanted to start his investment journey with $2,000 and then invest $600 every month. So, he found a broker that offered free deposits of any amount, connection with Jim’s bank account for instant deposits and a free automatic deposit service for his monthly inflows.
Apply your strategy
Once your funds are deposited, you can start actually building your portfolio by buying the assets you planned at the allocations you chose.
In future section, we will go more into detail and compare some of the best brokers in the world.
In the next section, we will explain the different types of trading orders you can execute.